Solutions Manual for Corporate Financial Management, 6th Edition By
Glen Arnold, Deborah Lewis -All Chapters( 1-22 ) Latest 2024
Chapter 1 : The Financial World
Learning outcomes
At the end of this chapter, the reader will have a balanced perspective on the purpose and value
of the finance function, at both the corporate and the national level. More specifically, the reader
should be able to:
• describe alternative views on the purpose of the business and show the importance to any
organization of clarity on this point;
• describe the impact of the divorce of corporate ownership from day-to-day managerial control;
• explain the role of the financial manager;
• detail the value of financial intermediaries;
• show an appreciation of the function of the major financial institutions and markets.
Key points and concepts
• Firms should clearly define the objective of the enterprise to provide a focus for decision
making.
• Sound financial management is necessary for the achievement of all stakeholder goals.
• Some stakeholders will have their returns satisficed – given just enough to make their
contribution. One (or more) group(s) will have their returns maximised – given any surplus after
all others have been satisfied.
• The assumed objective of the firm for finance is to maximize shareholder wealth.
Reasons:
• practical, a single objective leads to clearer decisions;
• the contractual theory;
• survival in a competitive world;
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• it is better for society;
• counters the tendency of managers to pursue goals for their own benefit;
• they own the firm.
• Maximising shareholder wealth is maximising purchasing power or maximising the flow
of discounted cash flow to shareholders over a long time horizon.
• Profit maximisation is not the same as shareholder wealth maximisation. Some factors a profit
comparison does not allow for:
• Corporate governance. Large corporations usually have a separation of ownership and
control. This may lead to managerialism where the agent (the managers) takes decisions
primarily with their interests in mind rather than those of the principals (the shareholders). This
is a principal–agent problem. Some solutions:
• corporate governance regulation;
• link managerial rewards to shareholder wealth improvement;
• sackings;
• selling shares and the takeover threat;
• improve information flow.
• Financial institutions and markets encourage growth and progress by mobilising savings
and encouraging investment.
• Financial managers contribute to firms’ success primarily through investment and finance
decisions. Their knowledge of financial markets, investment appraisal methods, treasury, risk
management and value analysis techniques is vital for company growth and stability.
• Financial institutions encourage the flow of saving into investment by acting as brokers and
asset transformers, thus alleviating the conflict of preferences between the primary investors
(households) and the ultimate borrowers (firms).
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• Asset transformation is the creation of an intermediate security with characteristics appealing
to the primary investor to attract funds, which are then made available to the ultimate borrower
in a form appropriate to them. Types of asset transformation:
• The secondary markets in financial securities encourage investment by enabling investor
liquidity (being able to sell quickly and cheaply to another investor) while providing the firm
with long-term funds.
• The financial services sector has grown to be of great economic significance in the United
Kingdom. Reasons:
• high income elasticity;
• international comparative advantage.
• The financial sector has shown remarkable dynamism, innovation and adaptability over the
last three decades. Deregulation, new technology, globalization and the rapid development of
new financial products have characterized this sector.
• Banking sector:
• Retail banks – high-volume and low-value business.
• International banks – mostly Eurocurrency transactions.
• Building societies – still primarily small deposits aggregated for mortgage lending.
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• Finance houses – hire purchase, leasing and factoring.
• Long-term savings institutions:
• Pension funds – major investors in financial assets.
• Insurance funds – life assurance and endowment policies provide large investment funds.
• The risk spreaders:
• Unit trusts – genuine trusts which are open-ended investment vehicles.
• Investment trusts – companies which invest in other companies’ financial securities,
particularly shares.
• Open-ended investment companies (OEICs) – a hybrid between unit and investment trusts.
• Exchange traded funds (ETFs) – set up as companies to invest in a range of securities.
• The risk takers:
• Private equity funds – invest in companies not quoted on a stock exchange.
• Hedge funds – wide variety of investment or speculative strategies outside regulators control.
• The markets:
• The money markets are short-term wholesale lending and/or borrowing markets.
• The bond markets deal in long-term bond debt issued by corporations, governments, local
authorities and so on, and usually have a secondary market.
• The foreign exchange market – one currency is exchanged for another.
• The share market – primary and secondary trading in companies’ shares takes place.
• The derivatives market – ICE Futures Europe dominates the ‘exchange-traded’ derivatives
market in options and futures in the United Kingdom. However, there is a flourishing over-the-
counter (OTC) market.
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